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A scalper sells a sports ticket for
cash. The amount that seller and buyer
value the ticket depends not just on its
perceived utility, but also on factors
such as the way the seller obtained it.people to adopt something, it
is more likely to be successful
if it emphasizes the positive gains
involved in making that decision. If,
on the other hand, it wants people
to reject something, it should focus
on what they stand to lose.
Processes and outcomes
Kahneman and Tversky also
showed that the process by which
decisions are made can affect
choices even when the process
doesn’t affect the final payoffs.
For example, imagine a game
of two stages in which a player is
given a choice of two options at the
second stage if they make it that
far. However, they must make their
choice before the first stage. An
example of such a game is laid
out on the opposite page.
In this two-stage game, most
people choose the guaranteed
$3,000 option. However, when the
decision is shown as a straight
choice between a lower chance of
winning $4,000 or a higher chance
of $3,000, most people choose the
lower chance of winning more
money. Why the change?
In the two-stage process
people ignore the first stage
because it is common to both
outcomes. They see the options as
a choice between a guaranteed
win and merely the chance of a win,
even though the probabilities are
altered by the first stage. This
contradicts standard economic
rationality in which decisions are
only influenced by final outcomes.
The end of rational man?
The key insights to this work—that
we hate to lose more than we like
to gain, and that we interpret
losses and gains in terms of
context—have helped illuminate
why people make decisions that are
not consistent with utility theory or
the idea of “rational economic man.”
The theory is a founding pillar of
behavioral economics, and has also
had wide-ranging influence
on marketing and advertising. By
understanding the way we make
decisions, marketers are able to
market their products much more
effectively. A good example of
this is in-store promotions,
which offer “huge discounts” on
items with initially inflated prices.
Prospect theory has
implications for many kinds of
common economic decisions.CONTEMPORARY ECONOMICS
For example, the theory explains
why people may travel to a different
part of town in order to save $5 off
a $15 DVD, but they are unlikely to
make the same trip in order to save
$5 off a $400 TV, even though their
net wealth is impacted by the same
amount in each case. Loss aversion
also explains what is known as the
endowment effect: people tend to
place a higher value on an object
when they own it—and do not want
to lose it—than before they own it,
when it is only a “potential gain.”
Behavioral economics is
vital to our understanding of the
economy and has introduced
psychological realism into modern
economics. Prospect theory was the
first to suggest that people are not
simply 100 percent rational
machines. The implications of this
realization—for economic theories
and government policies—are wide-
ranging. For example, giving people
a sense of ownership may affect how
well they look after something. ■One may discover that
the relative attractiveness of
options varies when the same
decision problem is framed
in different ways.
Amos Tversky
Daniel Kahneman